Covered Calls: Introduction
The long-stock plus short-call construction, its terminal payoff and the economic bargain embedded in premium.
#Long stock plus short call
Covered Call = Long Underlying + Short CallThe stock supplies one-for-one participation in the underlying. The sold call removes value when the terminal stock price exceeds the strike. Because the underlying quantity covers the call obligation, the strategy is called covered.
Coverage does not mean protected. The long stock can still lose most or all of its value. It means the option obligation is paired with the asset needed to satisfy the call economically or physically.
#Terminal payoff
S_T − max(S_T − K, 0) = min(S_T, K)- S_T
- underlying price at expiry
- K
- strike
min(S_T, K) + PBelow the strike, the call contributes no intrinsic loss and the position follows the stock plus premium. Above the strike, each additional unit of stock value is offset by an equal increase in the short call's obligation, so payoff flattens.
#The economic bargain
- Keep downside exposure to the stock, softened only by premium received.
- Keep upside between the entry price and strike.
- Receive premium for selling the call exposure.
- Surrender upside above the strike during the option term.
- OIC Covered Call (Buy/Write)
Options Industry Council educational reference for covered-call mechanics, payoff and assignment risk.